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The End Game
New York: November 22, 2010
By John Stephenson

Facing a staggering breadth of criticism from every corner of the globe, Ben Bernanke, the chairman of the U.S. Federal Reserve Board, hit back at critics in a speech in Frankfurt , Germany last week. The Germans and Chinese have accused the Fed of running a weak-dollar policy, while right wing economists and Republicans have staged an open campaign in the mainstream media against the Fed\\\\\\\'s efforts to resuscitate the American economy. To critics, the Fed\\\\\\\'s plan to create $600 billion to buy financial assets, or QE2, will lead to a massive debasement of the U.S. dollar and ultimately to inflation.

To buttress the Fed against a sea of criticism, Bernanke took his show on the road to deflect criticisms that his policies would stoke inflation. In his Frankfurt speech, Bernanke took aim at China and other emerging economies by saying that by refusing to let their currencies appreciate, their policies were condemning everyone to “slow growth.” By relying on export-driven growth strategies, emerging-market economies are tying themselves to the United States and other advanced economies. To his domestic critics, he politely suggested that they could end the political deadlock and start lending a hand to help get the more than 8.4 million Americans who\\\\\\\'ve lost their jobs since the start of the crisis back to work.

By turning the tables on his challengers, Bernanke\\\\\\\'s Frankfurt Speech went a long way toward refuting the notion that the Fed\\\\\\\'s asset purchasing plan is an act of desperation that will lead to inflation. And his speech succeeded in recasting the policies of China and other Asian countries as the problems with the world\\\\\\\'s foreign-exchange markets.

But this step designed to mollify the criticism that the Fed has been facing and to bolster public confidence in its efforts was a necessary one. And confidence is key to keeping asset prices, particularly stocks and real estate, moving steadily higher in America . Higher stock markets will allow the nation\\\\\\\'s banks to continue the process of paying down debt after the global financial crisis of 2008/2009.

And deleverage they must! The U.S. is in danger of entering another economic slump led once again by the country\\\\\\\'s battered and heavily leveraged banking sector. Rather than mark their assets to market, the U.S. banks have stubbornly refused to adhere to this practice and prefer instead to mark assets to model—a practice that helped hide their true financial health and exacerbated the financial crisis of 2008/2009. Instead of paying down debt and shoring up their financial health, American banks have taken money from the Fed and have been buying back their own stock.

Bank assets as a percent of GDP have surged from 53 percent in 1995 to more than 85 percent in early 2008. Currently, bank assets as a percentage of GDP sit at 80 percent, representing a huge overhang on the stock market and the economy. Already, the market has begun to take notice, with the KBW Banks Index (BKX) starting to roll over and head lower.

The next shoe to drop in the U.S. economy is the state and local governments, which are drowning in a sea of red ink. California has taken the unusual step of issuing IOUs to its state employees when its piggy bank is empty. With the household sector in trouble and all levels of American government facing a debt crisis, the only sector that is sitting pretty is the U.S. corporate sector, which is chockfull of cash. But America is alone in the world in its corporate tax policy, as the only country to double tax the foreign earnings of American companies. As a result, some 50 percent of the cash on American companies\\\\\\\' books is locked abroad, rather than repatriated and reinvested at home.

In spite of the criticism of the Fed and its unprecedented actions to jump start the American economy, Ben Bernanke and the Fed appear to be the only force in the U.S. helping to prevent a double dip recession. And while the emerging-market economies may not like it, global capital is going to chase after emerging-market assets as they offer superior returns to those alternatives in the stagnate West. This will help to further strengthen the currencies, stocks and real estate markets in those countries with rock-solid fundamentals.

With Ireland receiving a staggering 750 billion euro bailout package in a desperate bid to resuscitate its economy, don\\\\\\\'t look for any strength in the euro for the foreseeable future. The Japanese yen is plagued by a demographic disaster, where the country has more morticians than obstetricians and the prospect of a solid economic recovery is nowhere in sight. In the U.S. , things could hardly be worse with gridlock the order of the day in the legislative branch of government and the Fed increasing the money supply daily.

In a climate like this, the rich will get richer and the poor will fall by the wayside. Global capital flows will continue to migrate toward the emerging markets and commodities, which are an indirect play on global growth. Savvy investors should overweight emerging markets and the stocks in commodity producing countries, such as Canada and Australia as well as gold and precious metals. Increasingly, investors are saying that they just can\\\\\\\'t trust the value of paper money any more. With what been going on, who can blame them?

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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